A] LTA replaced by LSA & LSDBA in April 2024
On 6 April 2024, the lifetime allowance (LTA) was formally abolished and a new regime for the taxation of lump sums and lump sum death benefits was introduced.
The lifetime allowance was replaced with three different allowances:
- 1] The Lump Sum Allowance (LSA): £ 268,275
- 2] The Lump Sum And Death Benefit Allowance (LSADBA): £ 1,073,100
- 3] The Overseas Transfer Allowance (OTA): £ 1,073,100
A check is made against these allowances when benefits are paid. These allowances may be higher if the individual already has lifetime allowance protection due to the past.
These allowances are reduced if benefits were taken between 6 April 2006 and 5 April 2024.
B] What is happening?
From 6 April 2024, the LTA is abolished and a new regime for the taxation of lump sums and lump sum death benefits is introduced. This is the most significant change to the UK pensions tax regime for nearly two decades!
C] What is the LTA?
The LTA is the maximum amount of tax-relieved pension savings that an individual can make over their lifetime. (UK State Pension Claims not included.) When originally introduced in 2006, the LTA was set at £1.5 million. In the past it has been reduced and recently it was £1.073 million.
When first introduced, and each subsequent time it was reduced, individuals with savings in excess of the LTA (or the reduced LTA, as applicable) were able to apply to retain a higher, “protected” LTA. In some cases (known as enhanced and fixed protection), the individual would lose their LTA protection if they made further pension savings.
The LTA charge is payable when benefits—whose value exceeds the LTA—are taken, and is payable on the value in excess of the LTA. Until 6 April 2023, the LTA charge was 55% where the excess was taken as a lump sum, and 25% where the excess was taken as regular annual pension annuity. However, starting 6 April 2023, the LTA charge was reduced to the individual’s marginal tax rate, as a precursor to abolition of the LTA.
D] What will replace the LTA?
On 6 April 2024, a new “lump sum allowance” of £268,275 (i.e., 25% of the current LTA) and a new “lump sum and death benefit allowance” of £1,073,000 (i.e., the current LTA) will be created. Individuals will not pay tax where the non-taxable element of lump sums they receive does not take them above these levels.
To the extent that the otherwise non-taxable element of a lump sum exceeds these levels, it will be taxed at the recipient’s marginal rate (except where LTA protections apply). The allowances will be personal, rather than applying at a scheme level, and will not take into consideration the payment of regular pension income.
Existing LTA protections will remain relevant, as they will give the individual higher lump sum and lump sum and death benefit allowances. Since 6 April 2023, individuals with enhanced or fixed protection will not lose that protection if they make further pension savings, provided they applied for the protection before 15 March 2023.
E] When do you test against the lump sum and death benefit allowance?
The lump sum and death benefit allowance applies at a relevant benefit crystallisation event, when someone dies or on the payment of a serious ill-health lump sum.
It is important to remember most tax-free benefits paid during the individual’s lifetime are also deducted from this allowance. (There are some exceptions.)
F] What is a relevant benefit crystallisation event (RBCE)?
It is important to note, despite using similar words, relevant benefit crystallisation events are very different from pre-6 April 2024 benefit crystallisation events.
Pre-6 April 2024, benefit crystallisation events related to benefits, taxable and tax-free, being taken in a specific way and time which resulted in the individual’s lifetime allowance being used up.
Post 5 April 2024, a relevant benefit crystallisation event relates solely to the tax-free element of the benefits being taken. There are no relevant benefit crystallisation events for taxable pension income.
The definition of relevant benefit crystallisation event depends on whether you are looking at the lump sum allowance or the lump sum and death benefit allowance.
For the lump sum allowance a relevant benefit crystallisation event in relation to an individual, is defined as, the individual becoming entitled to:
- a pension commencement lump sum, or
- an uncrystallised funds pension lump sum.
For the lump sum and death benefit allowance a relevant benefit crystallisation event in relation to an individual is defined as:
- the individual becoming entitled to a relevant lump sum, or
- a person being paid a relevant lump sum death benefit in respect of the individual.
A relevant lump sum is defined as:
- a pension commencement lump sum;
- a serious ill-health lump sum, or;
- an uncrystallised funds pension lump sum.
A relevant lump sum death benefit means any authorised tax-free lump sum death benefit other than:
- a charity lump sum death benefit, or;
- a trivial commutation lump sum death benefit.
G] What benefits are included in the two allowances?
Although both allowances relate to tax-free benefits, what counts towards them is different.
The lump sums tested against the lump sum allowance during the lifetime include:
- pension commencement lump sums.
- the tax-free elements of any uncrystallised funds pension lump sum.
The tax-free lump sums tested against the lump sum and death benefit allowance include:
- Pension commencement lump sums and the tax-free elements of any uncrystallised funds pension lump sum.
- Uncrystallised funds lump sum death benefits.
- Drawdown pension fund lump sum death benefits and flexi-access drawdown lump sum death benefits from benefits crystallised on or after 6 April 2024.
- Serious ill-health lump sums.
- Defined benefit lump sum death benefits.
- Pension protection lump sum death benefits.
- Annuity protection lump sum death benefits.
- Lump sum death benefits paid after age 75 are not tax-free.
H] Are there any benefits not tested against the two allowances?
The following benefits are not tested against the allowances:
I. Lump sum payments under £10,000 are not tested against either of the allowances.
II. The following benefits are not tested against the lump sum allowance:
- a winding up lump sum;
- a trivial commutation lump sum.
III. The following benefits are not tested against the lump sum and death benefits allowance:
- a charity lump sum death benefit;
- a trivial commutation lump sum death benefit.
A transfer to a qualifying recognised overseas pension scheme and a disqualifying pension credit are not included as these are not paid tax-free.
I] What tax is payable on the non-tax-free benefits?
Benefits that exceed the lump sum allowance or the lump sum and death benefit allowance are liable to income tax at the recipient’s marginal rate, as are the ‘income’ parts of any benefits taken, such as an annuity or income taken from a drawdown plan.
What do we mean by marginal rate of income tax? This means the amount being paid out is added to the recipient’s income and taxed accordingly. As an example, if the recipient was tax resident in England and had income of £60,000 and received £20,000, the whole £20,000 falls within the higher rate income tax band and will taxed at 40%.
There is no change to the tax paid if death benefits are paid to a trust and not directly to a beneficiary.